Legacy Wealth Weekly - Oct 07, 2016 (Pound Pounded)

Penni Johnston-gill - Oct 07, 2016

US and Canadian equities were down ~1% this week but considering the upward move in global bond yields, it is a moral victory for bulls. Rumours that the BoJ is now targeting the Yen, the ECB could be tapering its bond purchase program and more Fed o

Weekly Market Wrap-Up: Pound Pounded

US and Canadian equities were down ~1% this week but considering the upward move in global bond yields, it is a moral victory for bulls. Rumours that the BoJ is now targeting the Yen, the ECB could be tapering its bond purchase program and more Fed officials talking rate increases are such that G7central bankers could be sending a message that non-conventional easing policies have reached their efficacy limits. Unsurprisingly, gold and gold equities plunged as speculators likely unwound crowded long positions in gold pits and gold bullion ETFs. As we explained this week, we believe this is a buying opportunity but the bottoming phase will be volatile. Another highlight is the price of oil, which has pushed above the $50/bbl level, thanks to the OPEC freeze sending short-sellers to the sidelines. Oil inventories have now gone down in 15 weeks out of the last 21. Oil-price strength has not been able to pull the CDN$ higher. We warned last week about an upcoming decoupling; here we are with the Loonie down to multi-week lows of around 75 cents. Another weak currency is the pound sterling, which has broken down to three-decade lows upon comments from the UK government that it plans to invoke Article 50 for Brexit by the end of March 2017.

We received several inquiries about this week’s plunge in the pound, with investors wondering how low it can go. Other questions were if there were any implications for gold bullion. On the first point, our Chart of the Week plots the British pound (GPB/USD) relative to its purchasing power parity. As we can see, other than during the US$ craze in the early 80s, the pound bottomed out when trading ~10% below PPP. At ~US$1.24 currently, we are 13% below PPP at US$1.43. If history holds, this week’s flash crash may have coincided with a secular bottom in the pound. Now, what is the implication for gold? Well, it would be a positive development. As the third panel shows, secular bottoms in the pound sterling (16% of the DXY) have also usually coincided with bottoms in the price of gold. This is another reason why investors should adopt a buy-on-dip mentality with gold(s) at current levels.

Regarding economic statistics this week, the Canadian economy registered a 67k employment increase in September (vs. 10k exp.), driven by self-employed workers (+50k). Divided differently, full-time employment rose 23k while part-time employment surged 44k, with most of the new jobs created in Quebec (+38k). Summing it up, the headline number probably overestimates the real strength of the economy, especially when considering the RBC mfg. PMI decline (50.3, from 51.1) and the trade balance deficit (C$1.9B). These indicators suggest the CDN$ is too strong. In the US, nonfarm payrolls somewhat disappointed with a 156k print (vs. 175k exp.). This number comes at odds with the release of upbeat US PMIs earlier this week, given that the ISM mfg. and service indexes jumped to 51.5 (from 49.4) and 57.1 (from 51.4), respectively. In Europe, the mfg. PMI advanced to 52.6 (from 51.7) while the decline in the service PMI (52.2, from 52.8) seems consistent with slowing growth in retail sales (0.6% YoY, from 1.8%). In Japan, PMI releases highlighted a similar decoupling with the mfg. and service indexes at 50.4 (from 49.5) and 48.2 (from 49.6), respectively. Finally, in India, the new regime at the RBI led by Governor Urjit Patel surprised investors with a 25bps rate cut. Hopefully the rate cut will support economic growth as both the mfg. (52.1) and service PMIs (52.0) softened in September.

Next week, the NFIB, producer prices and retail sales should help gauge the US economy. Otherwise, we will focus on the Caixin service PMI, the trade balance, inflation and loan growth in China.

The Canaccord Genuity research included in the Legacy Wealth Weekly is solely for Canadian residents. To subscribe to our weekly newsletter, click here.